UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC FORM 10-K

Transcription

1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC FORM 10-K (Mark One) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2014 TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from Commission File Number: HEALTH NET, INC. (Exact Name of Registrant as Specified in Its Charter) Delaware (State or Other Jurisdiction (I.R.S. Employer of Incorporation or Organization) Identification No.) Oxnard Street, Woodland Hills, CA (Address of Principal Executive Offices) (Zip Code) Registrant s Telephone Number, Including Area Code: (818) Securities Registered Pursuant to Section 12(b) of the Act: Title of each class Name of each exchange on which registered Common Stock, $.001 par value The New York Stock Exchange Rights to Purchase Series A Junior Participating Preferred Stock The New York Stock Exchange Securities Registered Pursuant to Section 12(g) of the Act: None Indicate by check mark whether the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes No Indicate by check mark whether the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes No Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes No Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T ( of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes No Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check one): Large accelerated filer Accelerated filer Non-accelerated filer Smaller reporting company (Do not check if a smaller reporting company) Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes No The aggregate market value of the voting stock held by non-affiliates of the registrant as of June 30, 2014 was $3,265,069,381 (which represents 78,600,611 shares of Common Stock held by such non-affiliates multiplied by $41.54, the closing sales price of such stock on the New York Stock Exchange on June 30, 2014). The number of shares outstanding of the registrant s Common Stock as of February 23, 2015 was 76,903,375 (excluding 76,238,167 shares held as treasury stock). Documents Incorporated By Reference Part III of this Form 10-K incorporates by reference certain information from the registrant s definitive proxy statement for its 2015 Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission within 120 days after the close of the year ended December 31, to

2 HEALTH NET, INC. INDEX TO FORM 10-K PART I. Item 1 Business... General... Segment Information... Provider Relationships... Additional Information Concerning Our Business... Government Regulation... Intellectual Property... Employees... Dependence Upon Customers... Shareholder Rights Plan... Potential Acquisitions and Divestitures... Item 1A Risk Factors... Item 1B Unresolved Staff Comments... Item 2 Properties... Item 3 Legal Proceedings... Item 4 Mine Safety Disclosures.... PART II. Item 5 Market For Registrant s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities... Item 6 Selected Financial Data... Item 7 Management s Discussion and Analysis of Financial Condition and Results of Operations... Item 7A Quantitative and Qualitative Disclosures About Market Risk... Item 8 Financial Statements and Supplementary Data... Item 9 Changes in and Disagreements with Accountants on Accounting and Financial Disclosure... Item 9A Controls and Procedures... Item 9B Other Information... PART III. Item 10 Directors, Executive Officers of the Registrant and Corporate Governance... Item 11 Executive Compensation... Item 12 Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters... Item 13 Certain Relationships and Related Transactions, and Director Independence... Item 14 Principal Accountant Fees and Services... PART IV. Item 15 Exhibits and Financial Statement Schedule... SIGNATURES... Index to Consolidated Financial Statements... Report of Independent Registered Public Accounting Firm... Supplemental Schedule... Page F-1 F-2 F-63

3 PART I Item 1. Business. General We are a publicly traded managed care organization that delivers managed health care services through health plans and government-sponsored managed care plans. Our mission is to help people be healthy, secure and comfortable. In this Annual Report on Form 10-K, unless the context otherwise requires, the terms Company, Health Net, we, us, and our refer to Health Net, Inc. and its subsidiaries. We provide and administer health benefits to approximately 6.0 million individuals across the country through group, individual, Medicare (including the Medicare prescription drug benefit commonly referred to as "Part D"), Medicaid, dual eligible, U.S. Department of Defense ( Department of Defense or DoD ), including TRICARE, and U.S. Department of Veterans Affairs programs. Through our subsidiaries, we also offer behavioral health, substance abuse and employee assistance programs, managed health care products related to prescription drugs, managed health care product coordination for multi-region employers, and administrative services for medical groups and self-funded benefits programs. We were incorporated in Our current operations are the result of the April 1, 1997 merger transaction (the "FHS Combination") involving Health Systems International, Inc. ("HSI") and Foundation Health Corporation. We changed our name to Health Net, Inc. in November Prior to the FHS Combination, we were the successor to the business conducted by Health Net of California, Inc., now our HMO subsidiary in California, and HMO and PPO networks operated by QualMed, Inc., which combined with us in 1994 to create HSI. Our executive offices are located at Oxnard Street, Woodland Hills, California 91367, and our Internet website address is We make available free of charge on or through our Internet web site, our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K and all amendments to those reports filed or furnished pursuant to Section 13(a) or Section 15(d) of the Securities Exchange Act of 1934, as amended (the Exchange Act ) as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission ( SEC ). Such materials also are available free of charge on the SEC website, Copies of our Corporate Governance Guidelines, Code of Business Conduct and Ethics, Director Independence Standards and charters for the Audit Committee, Compensation Committee, Governance Committee and Finance Committee of our Board of Directors also are available on our Internet website. We will provide electronic or paper copies free of charge upon request. Please direct your written request to Investor Relations, Health Net, Inc., Oxnard Street, Woodland Hills, California 91367, or contact Investor Relations by telephone at (818) We have included our and the SEC s Internet website addresses throughout this Annual Report on Form 10-K as textual references only. The information contained on these websites is not incorporated into this Annual Report on Form 10-K. Our transfer agent, Wells Fargo, can help you with a variety of shareholder-related services, including change of address, lost stock certificates, transfer of stock to another person and other administrative services. You can write to our transfer agent at: Wells Fargo Shareowner Services, P.O. Box 64854, St. Paul, Minnesota , stocktransfer@wellsfargo.com, or telephone (800) or (651) Segment Information Our reportable segments for 2014 are comprised of Western Region Operations and Government Contracts. Effective January 1, 2013, our Divested Operations and Services was closed out after completion of transition and runout activities related to our sold businesses as discussed below. For additional financial information regarding our reportable segments, see Results of Operations in Item 7. Management s Discussion and Analysis of Financial Condition and Results of Operations and Note 14 to our consolidated financial statements included as part of this Annual Report on Form 10-K. Western Region Operations Segment Our Western Region Operations segment includes the operations of our commercial, Medicare and Medicaid health plans as well as the operations of our health and life insurance companies and certain operations of our behavioral health and pharmaceutical services subsidiaries, primarily in Arizona, California, Oregon and Washington. As of December 31, 2014, we had approximately 3.2 million risk members in our Western Region Operations segment. 1

4 Managed Health Care Operations We offer a full spectrum of managed health care products and services. Our strategy is to create affordable and tailored customer solutions by (i) seeking to provide product offerings that both anticipate and respond to current and emerging market demands; (ii) pursuing innovative provider relationships that effectively manage the cost of care; and (iii) building alliances with other stakeholders in the health care system to identify and implement changes to help improve the quality and accessibility of the health care system. The pricing of our products is designed to reflect the varying costs of health care based on the benefit alternatives in our products. Our health plans offer members coverage for a wide range of health care services including ambulatory and outpatient physician care, hospital care, pharmacy services, behavioral health and ancillary diagnostic and therapeutic services. Our health plans include a matrix package, which allows employers and members to select their desired coverage from a variety of alternatives. Our principal commercial health care products are as follows: HMO Plans: Our health maintenance organization or HMO plans offer comprehensive benefits generally for a fixed fee or premium that does not vary with the extent or frequency of medical services actually received by the member. We offer HMO plans with differing benefit designs and varying levels of copayments at different premium rates. These plans are offered generally through contracts with participating network physicians, hospitals and other providers. When an individual enrolls in one of our HMO plans, he or she selects a primary care physician ( PCP ) from among the physicians participating in our network. PCPs generally are family practitioners, general practitioners or pediatricians who provide necessary preventive and primary medical care, and are generally responsible for coordinating other necessary health care services, including making referrals to participating network specialists. In California, participating providers are typically contracted through medical groups and independent physician associations. In those cases, enrollees in HMO plans are generally required to secure specialty professional services from physicians in the group, as long as such services are available from group physicians. A significant majority of our California membership is in HMO plans. PPO Plans: Our preferred provider organization or PPO plans offer coverage for services received from any health care provider, with benefits generally paid at a higher level when care is received from a participating network provider. Coverage typically is subject to deductibles and co-payments or coinsurance. POS and EOA Plans: Our point of service or POS plans and our elect open access or EOA plans blend the characteristics of HMO, PPO and indemnity plans. Members can have comprehensive HMO-style benefits for services received from participating network providers with lower copayments (particularly within the medical group), but also have coverage, generally at higher copayment or coinsurance levels or with coverage limitations, for services received outside the network. EPO Plans and HSP: Our Exclusive Provider Organization or EPO plans and Healthcare Service Plans or HSP similarly blend elements of traditional HMO and PPO plans. Referrals are not required for in-network specialty care, but there are no out of network benefits other than emergency care. In some, but not all, plans members select a PCP that coordinates most care. The Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010 (collectively, the ACA ) has altered and continues to alter the dynamics of the health care insurance industry. The breadth and scope of these changes have presented us with a number of new and substantial business opportunities as well as a number of strategic and operational challenges. Among other things, the ACA required the modification of existing commercial products and the development of new products beginning with the 2014 benefit year. In response, we developed new health plans both for the ACA s individual health insurance exchanges and for off-exchange use that met the ACA s essential health benefits standard and other requirements. These products incorporated new cost sharing features as required by the ACA. Whether sold through the exchange or off-exchange, these products also had to meet the requirements of four metal tiers-bronze, Silver, Gold and Platinum. Plans offered in each tier have to achieve a prescribed actuarial value. On the exchanges we must offer at least one silver and one gold product. We also offer catastrophic plans. For additional information on the exchanges, see " Western Region Exchanges." In recent years, the health care industry has seen a renewed interest in the managed care model. The evolving health care landscape, including the changes presented by the ACA and related state initiatives and regulations, have, among other things, resulted in increased popularity of health care delivery systems that focus on coordination of care and cost management, particularly through the use of fixed payment models, otherwise referred to as capitation. A recent example is California s Coordinated Care Initiative, or CCI, which required that California Medicaid ( Medi- Cal ) beneficiaries in the participating CCI counties receive their benefits from managed care health plans. For additional information on the CCI, see " California Coordinated Care Initiative." 2

5 In addition, we believe that economic pressures have caused customers (both individuals and employer groups) increasingly to make health insurance purchasing decisions based on value versus choice. We believe that many customers are choosing health plans that offer better financial value over health plans that may offer broader networks that require higher premiums. We have developed and are selling products using tailored networks to meet this need. These tailored network products use dedicated provider networks that share our commitment to quality health care and affordability. These products also incorporate benefit levels that help ensure our members have access to the care they need. We offer tailored network HMO, EPO or HSP products throughout our Western Region Operations segment. These products are structured in a variety of ways. They may include a tiered provider option, be organized in conjunction with a strategic provider partner or be created specifically for particular populations and geographically proximate networks. For example, our HMO CommunityCare SM product offers a network of HMO doctors, specialists and hospitals designed to meet the unique needs of the individual exchange markets. Our Salud Con Health Net SM product line is a suite of affordable plans developed for the Latino community. In addition, we have developed tailored network products with strategic provider partners in California, Arizona, Oregon and Washington, and we have developed customized products for large employer groups with a large geographic distribution within a particular state. We believe our strength in tailored network products has been an important factor in the enrollment growth that we experienced in 2014 in both our on-exchange and off-exchange HMO, EPO or HSP plans that utilize tailored networks. We assume both underwriting and administrative expense risk in return for the premium revenue we receive from our HMO, POS, PPO/EOA and HSP products. In California, under a capitation payment model, we pay a provider group a fixed amount per member on a regular basis, usually monthly, and the provider group accepts the risk of the frequency and cost of member utilization of professional services. We believe that capitation payment models incentivize providers to focus more on preventive care and cost management. Under these payment models, we believe members are more likely to receive a comprehensive array of appropriate and timely preventive services than in feefor-service models, thereby helping to improve members health, reduce the need for more costly acute care interventions and, in so doing, lower the rate of growth of health care costs. With its focus on improving patient care through shared risk amongst providers and health insurers, the capitation payment model shares certain similarities with the Accountable Care Organization ( ACO ) model that is one of the ACA s primary initiatives for improving the quality and efficiency of health care delivery systems. See Provider Relationships for additional information about our capitation fee arrangements and Item 1A. Risk Factors-If we fail to develop and maintain satisfactory relationships on competitive terms with the hospitals, provider groups and other providers that provide services to our members, our profitability could be adversely affected for additional information on the challenges we face with providers in the changing health care environment. As of December 31, 2014, approximately 67% of our California commercial membership was enrolled in capitated medical groups. In addition, approximately 70% of our Medicare, 73% of our Medicaid and all of our dual eligibles businesses are linked to capitated provider groups. As of December 31, 2014, 63% of our commercial members in our Western Region Operations segment were covered by conventional HMO products, 34% were covered by POS and PPO products, and 3% were covered by other related products. Membership in our tailored network products was approximately 50% of total commercial membership as of December 31, 2014, compared with 38% as of December 31, As of December 31, 2014, approximately 64% of our California commercial capitated membership was enrolled in tailored network products. The following table contains membership information relating to our commercial large group (generally defined as an employer group with more than 50 employees) members, commercial small group (defined as employer groups with 2 to 50 employees) members, commercial individual members, Medicare Advantage members, Medicaid members, and dual eligibles members as of December 31, 2014 (our Medicare, Medicaid and dual eligibles businesses are discussed below under Medicare Products, Medicaid and Related Products and California Coordinated Care Initiative," respectively): Commercial Large Group ,523 (a) Commercial Small Group ,073 (b) Commercial Individual ,082 (c) Medicare Advantage ,781 Medicaid... 1,675,801 Dual Eligibles... 16,426 3

6 (a) Includes 360,901 HMO members, 92,849 POS members, 58,802 PPO members, 9,461 EPO members and 24,510 members in other related products. (b) Includes 153,299 HMO members, 21,021 POS members, 137,717 PPO members and 1,036 EPO members. (c) Includes 233,696 HMO members, 2,842 POS members, 95,521 PPO members, and 23 EPO members. As of December 31, 2014, our total membership was comprised of approximately 38% commercial, 8% Medicare Advantage, 53% Medicaid, and 1% dual eligibles. As of December 31, 2014, our commercial enrollment was comprised of approximately 46% large group, 26% small group and 28% individual accounts. Our membership in individual accounts increased from 11% of our commercial enrollment as of December 31, 2013, driven in large part by membership increases in the health insurance exchanges, which are further described below under the heading Western Region Exchanges. The following table sets forth certain information regarding our employer groups in the commercial managed care operations of our Western Region Operations segment as of December 31, 2014: Number of Employer Groups... 27,965 Largest Employer Group as % of commercial enrollment % 10 largest Employer Groups as % of commercial enrollment % Detailed membership information regarding our health plan operations in Arizona, California, Oregon and Washington health plans is set forth below. See Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Results of Operations Western Region Operations Reportable Segment Western Region Operations Segment Membership for a discussion on changes in our membership levels during Arizona. Our Arizona health plan operations are conducted by our subsidiaries, Health Net of Arizona, Inc., Health Net Access, Inc. and Health Net Life Insurance Company ( HNL ). Our commercial membership in Arizona was 178,064 including 60,743 tailored network members, as of December 31, Our Medicare Advantage membership in Arizona was 45,873 as of December 31, Our Medicaid membership in Arizona was 80,913 as of December 31, California. In California, our health plan operations are conducted by our subsidiaries Health Net of California, Inc. ( HN California ), Health Net Community Solutions, Inc. ( HNCS ), and HNL. HN California, our California HMO for commercial and Medicare Advantage programs, and HNCS, our California HMO for Medicaid programs, together constitute one of the largest HMOs in California as measured by total membership and together have one of the largest provider networks in California. Our commercial membership in California as of December 31, 2014 was 957,495, including 523,890 tailored network members. Our Medicare Advantage membership in California as of December 31, 2014 was 172,554. Our Medicaid membership in California as of December 31, 2014 was 1,594,888 members. Our dual eligibles membership in California as of December 31, 2014 was 16,426 members. Northwest. The Northwest includes our Oregon and Washington health plan operations, which are conducted by our subsidiaries, Health Net Health Plan of Oregon, Inc. ( HNOR ) and HNL. Our commercial membership in Oregon was 47,646 including 8,240 tailored network members, as of December 31, Our commercial membership in Washington was 8,473 as of December 31, Our Medicare Advantage membership in Oregon and Washington was 56,354 as of December 31, We did not have any Medicaid members in Oregon or Washington as of December 31, Medicaid and Related Products We are one of the two largest Medicaid managed care health plans in California based on membership as of December 31, We experienced significant growth in our Medicaid business during 2014, primarily the result of Medicaid expansion under the ACA, which is discussed in further detail below under the heading Medicaid Expansion and Recent State Legislation. As of December 31, 2014, we had 1,594,888 members enrolled in Medi-Cal and other California state health programs, and we had 80,913 Medicaid members enrolled in Arizona. California To enroll in our Medi-Cal products, an individual must be eligible for Medicaid benefits in accordance with California's regulatory requirements. The State of California's Department of Health Care Services ( DHCS ) pays us a monthly fee for the coverage of our Medicaid members. The monthly fee is based on prepaid payment rates that are required by federal law to be actuarially sound, and ultimately determined by the State. The State considers a combination of various factors in setting these rates, including, without limitation, geographic area, a member's health 4

7 status, age, gender, county or region, benefit mix and member eligibility category. See Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Results of Operations Western Region Operations Reportable Segment Western Region Operations Segment Membership for detailed information regarding our Medicaid enrollment. Medi-Cal is a public health insurance program that provides health care services for low-income individuals residing in California, and is financed by the state of California and the federal government. As of December 31, 2014, through HNCS, we had Medi-Cal operations in 12 California counties: Fresno, Kern, Kings, Los Angeles, Madera, Riverside, Sacramento, San Bernardino, San Diego, San Joaquin, Stanislaus and Tulare. We are the sole commercial plan contractor with DHCS to provide Medi-Cal services in Los Angeles County, California. As of December 31, 2014, 848,898 of our Medi-Cal members resided in Los Angeles County, representing approximately 53% of our Medi-Cal membership. In November 2012, we entered into a state-sponsored health plans rate settlement agreement (the "Agreement") with DHCS to settle certain rate disputes related to prior years. Under the Agreement, DHCS agreed, among other things, to the extension of all of our Medi-Cal managed care contracts existing on the date of the Agreement, including our contract with DHCS to provide Medi-Cal services in Los Angeles County, for an additional five years from their existing expiration dates. As a result, our agreement to provide Medi-Cal services in Los Angeles County is currently scheduled to expire by its terms on March 31, The Agreement also established an account to track retrospective premium adjustments on all of our state-sponsored health care programs, including Medi-Cal, which includes our seniors and persons with disabilities population also referred to as the aged, blind and disabled ( SPDs ), our participation in the dual eligibles demonstration portion of the CCI that began in April 2014 and Medi-Cal expansion populations (our state-sponsored health care programs ) that also began in These retrospective premium adjustments are designed to help maintain minimum pretax margins with respect to our Medi-Cal operations. For additional information on the Agreement, see Note 2 to our consolidated financial statements, under the heading "Health Plan Services Revenue Recognition," to our consolidated financial statements included as part of this Annual Report on Form 10-K. Arizona In March 2013, we were awarded a contract by the Arizona Health Care Cost Containment System ("AHCCCS") to administer Medicaid benefits in Maricopa County, Arizona, beginning on October 1, AHCCCS uses federal, state and county funds to provide health care coverage to the State s acute and long-term care Medicaid populations, low income groups and small businesses. Since 1982, when it became the first statewide Medicaid managed care system in the nation, AHCCCS has operated under a federal Section 1115 Medicaid waiver authority that allows for the operation of a total managed care model. AHCCCS contracts for acute care services in seven geographic service areas that include 15 Arizona counties. Our contract for Maricopa County has an initial term of three years with two additional one-year extensions. In accordance with AHCCCS contractual requirements, we established a subsidiary, Health Net Access, Inc., whose sole activity is to perform the obligations under the AHCCCS contract. AHCCCS makes monthly prospective capitation payments to contracted health plans responsible for the delivery of care to members. As with our monthly fee under Medi-Cal, the monthly fee is based on prepaid payment rates that are required by federal law to be actuarially sound, and ultimately determined by the State. The State considers a combination of various factors in setting these rates, including, without limitation, geographic area, a member's health status, age, gender, county or region, benefit mix and member eligibility category. Medicaid Expansion and Recent State Legislation In connection with the ACA, the federal government extended funds to those states that opted to expand Medicaid eligibility from a pool that included residents with incomes up to 100% of the federal poverty level ( FPL ) to an expanded pool of residents with incomes up to 133% of the FPL. Both Arizona and California are amongst the states that have opted into this Medicaid expansion, which has increased and is expected to continue to increase our Medicaid membership. California also recently enacted a bill under which DHCS expanded the list of benefits that we are required to provide to our Medi-Cal population. Under this legislation, which became effective as of January 1, 2014, we began administering certain mental health outpatient benefits to all our Medi-Cal members, including those newly eligible as a result of Medicaid expansion, and closely coordinating mental health and substance abuse services activities with county mental health departments. 5

8 California Coordinated Care Initiative In 2012, the California legislature enacted the Coordinated Care Initiative, or CCI. The stated purpose of the CCI is to provide a more efficient health care delivery system and improved coordination of care to individuals that are fully eligible for Medicare and Medi-Cal benefits, or "dual eligibles," as well as to all Medi-Cal only beneficiaries who rely on long-term services and supports, or LTSS, which includes institutional long-term care and home and community-based services and other support services. In participating counties, the CCI established a voluntary dual eligibles demonstration, also referred to as the Cal MediConnect program, to coordinate medical, behavioral health, long-term institutional, and home- and community-based services for dual eligibles through a single health plan, and requires that all Medi-Cal beneficiaries in participating counties join a Medi-Cal managed care health plan to receive their Medi-Cal benefits, including LTSS. The DHCS selected eight counties to participate in the CCI, including Los Angeles and San Diego counties. On April 4, 2012, DHCS selected us to participate in the dual eligibles demonstration for both Los Angeles and San Diego counties. In December 2013, HNCS entered into a three-way agreement with DHCS and CMS, which was subsequently amended on January 13, 2014 (the Cal MediConnect Contract ). Among other things, under the Cal MediConnect Contract we have received and expect to continue to receive prospective blended capitated payments to provide coverage for dual eligibles in Los Angeles and San Diego Counties. In January 2014, CMS and DHCS informed us that based on its readiness assessments, we were able to enroll members beginning April 1, 2014, and could begin marketing for the dual eligibles demonstration in accordance with the guidelines and timeframes for Los Angeles and San Diego counties. Active enrollment in Los Angeles and San Diego counties for the dual eligible demonstrations commenced on April 1, 2014, and is scheduled to conclude at the end of During the active enrollment period, dual eligibles in Los Angeles County are able to either choose among us, the local health plan initiative, or one of three other health plans for benefits under the dual eligibles demonstration. On July 1, 2014, DHCS began automatically enrolling dual eligibles in Los Angeles County who have not selected a health plan, which we refer to as passive enrollment. Dual eligibles also may choose to opt out of the demonstration at any time. Such dual eligibles will then continue to receive Medicare services through either fee-for-service Medicare or the Medicare Advantage program, but will receive Medi-Cal benefits through a managed care health plan as required under the CCI. During the active enrollment period in San Diego County, dual eligibles are able to select to receive benefits from any one of four health plan options, including us, or opt out of the demonstration. Passive enrollment in San Diego County began on May 1, Based on our understanding of the passive enrollment methodology, we estimate that Health Net will receive approximately 47% and 20 25% of the passively enrolled dual eligibles in Los Angeles County and San Diego County, respectively. As of December 31, 2014, we had 16,426 dual eligibles members. Health Net s participation in the CCI, and the dual eligibles demonstration in particular, represents a significant business opportunity for us, but is subject to a number of risks inherent in untested health care initiatives, particularly those that involve new populations with limited cost experience. See Item 1A. Risk Factors Our participation in the dual eligibles demonstration portion of the California Coordinated Care Initiative in Los Angeles and San Diego Counties may prove to be unsuccessful for a number of reasons for a discussion of some of the risks associated with our participation in the CCI. The managed care services provided by HNCS to enrollees under the Cal MediConnect Contract include medical, prescription drug, LTSS, and behavioral health services. HNCS s responsibilities under the Cal MediConnect Contract also include providing traditional managed care services, including quality improvement, grievance and appeals, provider network establishment, and utilization management functions. HNCS also performs care coordination, case management services and health risk assessments, and develops individualized care plans for enrollees. We have developed our model for managing LTSS, building on our internal expertise and utilizing expert vendor resources to fulfill certain functions, including the risk stratification and health risk assessment (HRA) services required under the program. We have also developed our provider network for LTSS, including contracting with and training a variety of ancillary providers and capitated provider groups with a demonstrated capability for managing long-term care patients. Compensation. Under the Cal MediConnect Contract, we are compensated on a capitated, prospective permember-per-month basis, subject to CMS and DHCS modification of the capitation rates, which are currently based on the historical fee-for-service cost for providing care to dual eligibles. The Cal MediConnect Contract includes a risk adjustment process that adjusts the capitation payment to HNCS based on the health characteristics of the enrollee population, and includes risk corridor provisions that limit our upside financial gains and reduce our downside financial risk. DHCS and CMS also withhold a portion of capitation payments pending and payable upon satisfaction of certain pre-established quality standards. The financial performance of the Cal MediConnect Contract is included in the calculation of the settlement account that was established pursuant to the terms of the Settlement Agreement entered 6

9 into by DHCS, HNCS and Health Net of California, Inc. on November 2, 2012, which is further discussed above under the heading Western Region Operations Segment Medicaid and Related Products. Term and Termination. Assuming that no party elects to terminate or not to renew the Cal MediConnect Contract, the dual eligibles demonstration will continue through December 31, CMS or DHCS may immediately terminate the Cal MediConnect Contract for various reasons, or may terminate for no reason with 180 days prior written notice. Western Region Exchanges The ACA required the establishment of state-run or federally facilitated exchanges where individuals and small groups may purchase health coverage. California and Oregon received approval by the U.S. Department of Health and Human Services ( HHS ) and began operating state-run exchanges in HHS operates the exchange in Arizona. We currently participate as Qualified Health Plans ("QHPs") in the exchanges in California and Arizona. Open enrollment for the coverage year beginning January 1, 2015 began on October 1, 2014 and ended on February 15, Continued participation in these exchanges and future participation in any other exchanges in the states in which we operate may be conditioned on the approval of the applicable state or federal government regulator, which could result in the exclusion of some carriers from the exchanges. Certain factors to be considered for continued participation in the exchanges may be subject to change. We believe the exchanges represent a significant commercial business opportunity for us, and the growth we experienced through the first open enrollment period demonstrated that our tailored network products are particularly well suited to the exchange environment as demonstrated by the 21% of market share we acquired in the first year of the exchanges with 81% of that concentrated in our tailored network offerings as of December 31, As of December 31, 2014, we had approximately 269,784 active individual members through the California, Arizona and Oregon exchanges, including 182,962 in our Silver tier HMO product, CommunityCare SM. We have made and are continuing to make significant efforts to design and implement a cohesive operational and economic strategy with respect to the exchanges and the ACA s other relevant provisions, including premium stabilization provisions designed to apportion risk amongst insurers. Implementation of the exchanges remains ongoing, as significant portions of the insurance market, including small business groups, are expected to enter the exchanges for the first time in Moreover, in the second year of the exchanges, we expect that the marketplace will react to the pricing data, information and other feedback that is and becomes available following the completion of the first year of the exchanges. Accordingly, we will need to continue to monitor this market and remain nimble in our strategic approach. This changing framework may alter the economics and structure of our participation in the exchanges, and if we are not able to successfully adapt to any such changes in certain areas of our markets, our financial condition, cash flows and results of operations may be adversely affected. For a discussion of the risks related to the exchanges, and the state and federal government actions impacting the exchanges and the effect on our competitive landscape, see Item 1A. Risk Factors Federal health care reform legislation has had and will continue to have an adverse impact on the costs of operating our business and a failure to successfully execute our operational and strategic initiatives with respect thereto could adversely affect our business, cash flows, financial condition and results of operations, and Various health insurance reform proposals are also emerging at the state level, which could have an adverse impact on us. In the Arizona individual market we offer HMO products in three counties and PPO plans statewide both through the exchange and off- exchange. We offer HMO and PPO products to small business groups statewide both through the exchange and off-exchange. We currently operate in 13 of 19 exchange rating regions in California in the individual market, and in all 19 California exchange rating regions in the small business health options program ( SHOP ). In Southern California, we offer HMO and HSP products in the individual market that collectively cover all metal tiers and the catastrophic category level and offer PPO and EPO products that collectively cover all metal tiers in the SHOP. Outside of Southern California, we offer EPO products in the individual market that cover all metal tiers and the catastrophic category level and offer PPO and EPO products that collectively cover all metal tiers in the SHOP. Medicare Products We provide a wide range of Medicare products, including Medicare Advantage plans with and without prescription drug coverage and Medicare supplement products that supplement traditional fee-for-service Medicare coverage. Our subsidiaries have a number of contracts with the Centers for Medicare & Medicaid Services ( CMS ) under the Medicare Advantage program authorized under Title XVIII of the Social Security Act of 1935, as amended. Medicare Advantage Products As of December 31, 2014, we were one of the nation's largest Medicare Advantage contractors based on membership of 274,781 members. We contract with CMS under the Medicare Advantage program to provide Medicare 7

10 Advantage products directly to Medicare beneficiaries and through employer and union groups. We provide or arrange health care benefits for services normally covered by Medicare, plus a broad range of health care benefits for services not covered by traditional Medicare, usually in exchange for a fixed monthly premium per member from CMS that varies by the county in which the member resides, demographic factors of the member such as age, gender and institutionalized status, and the health status of the member. Any benefits that are not covered by Medicare may result in an additional monthly premium charged to the enrollee or through portions of payments received from CMS that may be allocated to these benefits, according to CMS regulations and guidance. Many of our Medicare Advantage members pay no monthly premium to us for these additional benefits. Our portfolio of Medicare Advantage plans focuses on simplicity so that members can use benefits with minimal paperwork and receive coverage that starts immediately upon enrollment. We also provide Medicare supplemental coverage to 28,801 members as of December 31, 2014 through either individual Medicare supplement policies or employer group sponsored coverage. We provide Medicare Advantage plans in select counties in Arizona, California, Oregon and Washington, and provide prescription drug benefits in most of our Medicare Advantage plan offerings. We also provide multiple types of Medicare Advantage Special Needs Plans, including dual eligible Special Needs Plans (designed for low income Medicare beneficiaries) in Arizona and California, chronic condition Special Needs Plans (designed for beneficiaries with congestive heart failure and diabetes) in California, Oregon and Arizona. These plans provide access to additional health care and prescription drug coverage. CMS developed the Medicare Advantage Star Ratings system to help consumers choose among competing plans, awarding between one and five stars to Medicare Advantage plans based on performance in certain measures of quality. The Star Ratings are used by CMS to award quality bonus payments to Medicare Advantage plans. Beginning with the 2014 Star Rating (calculated in 2013), Medicare Advantage plans were required to achieve a minimum of 4 Stars to qualify for a quality bonus payment in The methodology and measures included in the Star Ratings system can be modified by CMS annually and Star Ratings thresholds are based on performance of Medicare Advantage plans nationally. For the 2015 Star rating (calculated in 2014 for the 2016 payment year), our California HMO and Oregon HMO and PPO contracts with CMS were measured at 4.0 Stars, our Arizona HMO contract was measured at 3.5 Stars and our California PPO contract was measured at 3.0 Stars. See "Item 1A. Risk Factors Medicare programs represent a significant portion of our business and are subject to risk" for additional information on our star ratings. Indemnity Insurance Products We offer insured PPO, EPO and indemnity products as stand-alone products and as part of multiple option products in various markets. These products are offered by our health and life insurance subsidiaries, which are licensed to sell insurance in 49 states and the District of Columbia. Through these subsidiaries, we also offer auxiliary nonhealth products such as life, accidental death and dismemberment, dental, vision and behavioral health insurance. Our health and life insurance products are provided throughout most of our service areas. Other Specialty Services and Products We offer pharmacy benefits, behavioral health, dental and vision products and services (mostly through strategic relationships with third parties), as well as managed care products related to cost containment for hospitals, health plans and other entities as part of our Western Region Operations segment. Pharmacy Benefit Management We provide pharmacy benefit management ( PBM ) services to Health Net members through our subsidiary, Health Net Pharmaceutical Services ( HNPS ). As of December 31, 2014, HNPS provided integrated PBM services to approximately 3.0 million Health Net members who have pharmacy benefits, including approximately 269,000 of our Medicare members and approximately 16,000 of our dual eligibles members. HNPS manages these benefits in an effort to achieve the highest quality outcomes at the lowest cost for Health Net members. HNPS contracts with national health care providers, vendors, drug manufacturers and pharmacy distribution networks (directly and indirectly through a third party vendor), oversees pharmacy claims and administration, reviews and evaluates new FDA-approved drugs for safety and efficacy and manages data collection efforts to facilitate our health plans' disease management programs. In addition, HNPS provides affiliated health plans various services including development of benefit designs, cost and trend management, sales and marketing support, 8

11 and management delivery systems. HNPS outsources certain capital and labor-intensive functions of pharmacy benefit management, such as claims processing, mail order services and pharmacy network services. Behavioral Health We administer and arrange for behavioral health benefits and services through our subsidiary, Managed Health Network, Inc., and its subsidiaries (collectively MHN ). MHN offers behavioral health, and substance abuse programs on an insured and self-funded basis to groups in various states, and these programs and services are included as a standard part of most of our commercial health plans. MHN's benefits and services are also sold in conjunction with other commercial and Medicare products and on a stand-alone basis to unaffiliated health plans and employer groups. In addition, MHN administers employee assistance programs ( EAPs ) for groups in several states. Through our EAPs, we assess and refer employees of employer groups to a variety of non-medical services and information designed to improve workplace productivity. MHN also holds contracts with the U.S. Department of State ( State Department ) and the U.S. Agency for International Development ( USAID ) to provide EAP counseling services tailored for State Department and USAID employees and family members while posted overseas. In addition, effective January 1, 2014, we are required to administer certain mental health outpatient benefits to all our Medi-Cal members, including those newly eligible as a result of Medicaid expansion. MHN's products and services were provided to approximately 7.1 million individuals as of December 31, 2014, with approximately 147,000 individuals under risk-based programs, approximately 2.8 million individuals under selffunded programs and approximately 4.1 million individuals under EAPs, including those who are also covered under other MHN programs. In 2014, MHN's total revenues were $46.6 million. Of that amount, $3.0 million represented revenues from business with MHN affiliates and $43.6 million represented revenues from non-affiliate business. The foregoing excludes results and information related to MHN's administration and monitoring of the non-medical counseling program for the Department of Defense under the DoD sponsored Military Family and Life Counseling ( MFLC ) program formerly Military Family and Life Consultant program, which is reported in our Government Contracts reportable segment. See Government Contracts Segment Other Department of Defense Contracts. Dental and Vision We do not underwrite or administer stand-alone dental or vision products other than the stand-alone dental products that we underwrite in Oregon and Washington. During 2014 our current and prospective group plan members in Arizona and California had the option to elect private label dental products through a strategic relationship with Dental Benefit Providers, Inc. ( DBP ) and private label vision products through a strategic relationship with EyeMed Vision Care LLC ( EyeMed ). Those stand-alone dental products were underwritten and administered by DBP affiliated companies and the stand-alone vision products were underwritten by Fidelity Security Life Insurance Company and administered by EyeMed affiliated companies. DBP also administers dental products and coverage we provide to our members in Oregon and Washington, as well as to Medicaid enrollees in Arizona. Liberty Dental Plans of California, Inc. serves as the underwriter and administrator for the dental services we provide to our Medi-Cal enrollees. Vision Service Plan serves as the underwriter and administrator for the vision services we provide to our Medi-Cal enrollees in California and Medicaid enrollees in Arizona. Government Contracts Segment Our Government Contracts segment includes our government-sponsored managed care federal contract with the DoD under the TRICARE program in the North Region and other health care and behavioral health government contracts. On April 1, 2011, we began delivery of administrative services under the Managed Care Support Contract ( T-3 contract ) for the TRICARE North Region. Under the T-3 contract for the TRICARE North Region, we provide various types of administrative services including: provider network management, referral management, medical management, disease management, enrollment, customer service, clinical support service, and claims processing. Our Government Contracts segment also includes other health care and behavioral health government contracts, and subcontracts that we administer for the DoD, the U.S. Department of Veterans Affairs ( VA ) and certain other federal, state and local government entities. Certain components of these contracts are subcontracted to unrelated third parties. Amounts receivable under government contracts are comprised primarily of contractually defined billings, accrued contract incentives under the terms of the contract and amounts related to change orders for services not originally specified in the contract. In general, government receivables are estimates and are subject to government audit and negotiation. See Item 1A. Risk Factors Government programs represent an increasing share of our revenues. If we are unable to effectively administer these programs, if we do not effectively adapt to changes to these 9

12 programs, or if we experience a significant reduction in revenues from these government programs, it could have a material adverse effect on our business, financial condition or results of operations. TRICARE Our wholly owned subsidiary, Health Net Federal Services, LLC ( HNFS ), is a Managed Care Support Contractor in the North Region for the DoD TRICARE program. We have been serving the DoD since 1988 under the TRICARE program and its predecessor programs, and we believe we have established a solid history of operating performance in this line of business. We believe there will continue to be further opportunities to serve the DoD and other governmental organizations, such as the VA, in the future. We began providing services under the T-3 contract on April 1, The T-3 contract for the North Region covers Connecticut, Delaware, Illinois, Indiana, Kentucky (except Fort Campbell), Maine, Maryland, Massachusetts, Michigan, New Hampshire, New Jersey, New York, North Carolina, Ohio, Pennsylvania, Rhode Island, Vermont, Virginia, West Virginia, Wisconsin and the District of Columbia. In addition, the contract covers portions of the states of Iowa and Missouri. As a Managed Care Support Contractor for the T-3 contract for the TRICARE North Region, we provide administrative services to approximately 2.8 million Military Health System ( MHS ) eligible beneficiaries. Eligible active duty service members and their families, retired service members and their families, survivors of retired service members, and qualified former spouses are able to choose from a variety of TRICARE program options, including TRICARE Prime, which is similar to a conventional HMO plan. Non-active duty service members can select, on a caseby-case basis, to utilize TRICARE Extra, which is similar to a conventional PPO plan, or TRICARE Standard, which is similar to a conventional indemnity plan. Under TRICARE Prime, enrollees pay an enrollment fee (which is zero for active duty service members and their families) and select a primary care physician from our contracted provider network. The primary care physicians are responsible for making referrals to specialists and hospitals. Active duty service members and their families enrolled in TRICARE Prime have no copayments. However, all other TRICARE Prime enrollees are subject to copayments for medical services. TRICARE Prime enrollees may opt, on a case-by-case basis, for a Point-of-Service option in which they are allowed to self-refer to a network or non-network provider, but incur a deductible and a cost-share. The Point of Service option is not available for active duty service members. Under TRICARE Extra, eligible beneficiaries receive services from a TRICARE network provider but incur a deductible and cost-share that may be greater than the TRICARE Prime copayment. Beneficiaries utilizing TRICARE Extra realize a five percent cost-share savings over TRICARE Standard. Under TRICARE Standard, eligible beneficiaries receive services from a TRICARE authorized provider, either participating or non-participating, but incur a deductible and higher cost-share than under TRICARE Prime or TRICARE Extra. In addition, TRICARE offers premium-based health plans for eligible beneficiaries. Qualified Selected Reserve members may purchase TRICARE Reserve Select ( TRS ), which is a TRICARE Standard benefit. TRS members have the same costs as active duty family members. Qualified retired Reserve members may purchase TRICARE Retired Reserve ( TRR ), also a TRICARE Standard benefit. TRR members have the same costs as retired service members. TRICARE Young Adult ( TYA ) is available for purchase by eligible young adults under age 26. TRICARE currently offers a TYA Standard plan and a TYA Prime plan. The T-3 contract has five one-year option periods. We are currently in option period 5, which commenced on April 1, 2014 and is scheduled to end on March 31, In June 2014, at the request of the DoD, we submitted a proposal to add three additional one-year option periods to the T-3 contract. We currently expect negotiations relating to this proposal to conclude on or prior to March 31, If the negotiations conclude as expected, we expect the DoD to exercise the first of the three one-year options by that date. If all three one-year option periods are ultimately exercised, the T-3 contract would conclude on March 31, The DoD intends to re-procure managed care support services for the TRICARE program for the period beginning in 2017, and, to that end, released a draft Request for Proposals on November 3, The T-3 contract services are currently structured as cost reimbursement arrangements for health care costs plus administrative fees received in the form of fixed prices, fixed unit prices, and contingent fees and payments based on various incentives and penalties. For additional information regarding our previous TRICARE contract for the North Region and the T-3 contract for the North Region, see Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations and Item 1A. Risk Factors Government programs represent an increasing share of our revenues. If we are unable to effectively administer these programs, if we do not effectively adapt to changes to these programs, or if we experience a significant reduction in revenues from these government programs, it could have a material adverse effect on our business, financial condition or results of operations. 10

13 Military Family and Life Counseling Program. Our wholly owned subsidiary, MHN Government Services, is party to a MFLC contract that was awarded by the Department of Defense to implement, administer and monitor the non-medical counseling MFLC program. The contract was initially awarded in August of 2012 and is a second-generation contract under the MFLC program. The contract has a five-year term that includes a 12-month base period and four 12-month option periods. The DoD has exercised the first and second option periods under the contract, and the second option period is scheduled to end on August 14, For the year ended December 31, 2014, revenues from the MFLC contract were $119.7 million. For additional information on the risks associated with our MFLC contract, see Item 1A. Risk Factors Government programs represent an increasing share of our revenues. If we are unable to effectively administer these programs, if we do not effectively adapt to changes to these programs, or if we experience a significant reduction in revenues from these government programs, it could have a material adverse effect on our business, financial condition or results of operations. Patient Centered Community Care Program In September 2013, VA awarded HNFS a contract under its new Patient Centered Community Care ( PC3 ) program. The PC3 program provides eligible veterans coordinated, timely access to care through a comprehensive network of non-va providers who meet VA quality standards when a local VA medical center cannot readily provide the care. We support VA in providing care to veterans in three of the six PC3 program regions. These three regions, Regions 1, 2 and 4, encompass all or portions of 37 states, the District of Columbia, Puerto Rico and the Virgin Islands. The PC3 contract term includes a base period of performance through September 30, 2014 and four one-year option periods that may be exercised by VA. On September 23, 2014, VA exercised option period 1 which commenced on October 1, 2014 and is scheduled to end on September 30, In addition to the one-year option periods, VA has the ability to extend the PC3 program contract an additional two years and six months based on VA's need. In August 2014, VA expanded our PC3 contract to include primary care services for veterans who are unable to obtain primary care at a VA medical center in the three PC3 regions in which we operate. In addition, in November 2014, we modified our PC3 contract to further expand our services with VA in support of the Veterans Access, Choice and Accountability Act of 2014 ( VACAA ). VACAA allows eligible veterans who live more than 40 miles from a VA facility or are unable to get a VA appointment within 30 days of their preferred date, or within 30 days of the date determined medically necessary by their physician, to obtain approved care in their community instead. The VACAA modification to our PC3 contract (the "VACAA modification") expires no later than September 30, The VACAA modification includes, among other things, the production and distribution of the new Veterans Choice Card, which allows veterans to elect to receive care outside of VA when they qualify. As a result, approximately 5 million veterans have been provided with a Veterans Choice Card. Moreover, in connection with the VACAA modification, we operate a call center to assist veterans in determining their eligibility to use the card, and to help educate them on the VACAA. We also assist eligible veterans in obtaining an appointment with a community provider meeting VACAA requirements. We provide these services in the three PC3 regions in which we operate. For the year ended December 31, 2014, revenues from the PC3 contract were approximately $24.7 million. For additional information on the risks associated with our PC3 contract, see Item 1A. Risk Factors Government programs represent an increasing share of our revenues. If we are unable to effectively administer these programs, if we do not effectively adapt to changes to these programs, or if we experience a significant reduction in revenues from these government programs, it could have a material adverse effect on our business, financial condition or results of operations. Divested Operations and Services Segment Prior to the first quarter of 2012, our Divested Operations and Services reportable segment included the operations of our businesses that provided administrative services to UnitedHealth Group and its affiliates in connection with the Northeast Sale, which was completed on December 11, For information about the Northeast Sale, see Note 3 to our consolidated financial statements included as part of this Annual Report on Form 10-K (our "consolidated financial statements"). Due to the sale of our Medicare stand-alone prescription drug plan business on April 1, 2012, starting with the first quarter of 2012, Divested Operations and Services reportable segment included transition-related revenues and expenses related to the sale of our Medicare PDP business to an affiliate of CVS Caremark. As of December 31, 2012, we had substantially completed the administration and run-out of both of our divested businesses. 11

14 Provider Relationships The following table sets forth the number of primary care physicians, specialist physicians and other health professionals contracted either directly with our HMOs or through our contracted participating physician groups ( PPGs ) as of December 31, We have a number of physicians and other health professionals who are contracted providers for both HMOs and PPOs in our Western Region Operations, as follows: Primary Care Physicians (includes both HMO and PPO physicians)... 27,207 Specialist Physicians (includes both HMO and PPO physicians)... 61,882 Health Professionals - Other (includes both HMO and PPO)... 35,029 Total ,118 Under our California HMO, EPO, HSP and POS plans, all members are required to select, or otherwise will be assigned to, a PPG and generally also a primary care physician from within the PPG. In our other plans, including all of our plans outside of California, members may be required to select a primary care physician from the broader HMO network panel of primary care physicians. The primary care physicians and PPGs assume overall responsibility for the care of members. Medical care provided directly by such physicians includes the treatment of illnesses not requiring referral, and may include physical examinations, routine immunizations, maternity and childcare, and other preventive health services. The primary care physicians and PPGs are responsible for making referrals (approved by the HMO's or PPG's medical director as required under the terms of our various plans and PPG contracts) to specialists and hospitals. Additionally, our tailored network products utilize a network that is smaller than our broader HMO network but contains a comprehensive array of physicians, specialists, hospitals and ancillary providers. Certain of our HMOs offer enrollees open access plans under which members are not required to secure prior authorization for access to network physicians in certain specialty areas, or open panels under which members may access any physician in the network, or network physicians in certain specialties, without first consulting their primary care physician. PPG and physician contracts generally are for a period of at least one year and are automatically renewable unless terminated, with certain requirements for maintenance of good professional standing and compliance with our quality, utilization and administrative procedures. In California, PPGs generally receive a monthly capitation payment for every member assigned to it. The capitation payment represents payment in full for all medical and ancillary services specified in the provider agreements. For these capitation payment arrangements, in cases where the capitated PPG cannot provide the health care services needed, such PPGs generally contract with specialists and other ancillary service providers to furnish the requisite services under capitation agreements or negotiated fee schedules with specialists. Outside of California, most of our HMOs reimburse physicians according to a discounted fee-for-service schedule, although several have capitation arrangements with certain providers and provider groups in their market areas. A provider group's financial instability or failure to pay secondary providers for services rendered could lead secondary providers to demand payment from us, even though we have made our regular capitated payments to the provider group. Depending on state law and the regulatory environment, it may be necessary for us to pay such claims. In our PPO plans, members are not required to select a primary care physician and generally do not require prior authorization for specialty care. For services provided under our PPO products and the out-of-network benefits of our POS products, we ordinarily reimburse physicians pursuant to discounted fee-for-service arrangements. HNFS maintains a network of qualified physicians, facilities, and ancillary providers in the prime service areas of our T-3 contract for the TRICARE North Region. Services are provided on a fee-for-service basis. As of December 31, 2014, HNFS had 223,222 physicians, 3,862 facilities and 20,693 ancillary providers in its TRICARE network. HNFS also maintains a provider network comprised of approximately 49,270 providers in Regions 1, 2, and 4 in support of VA s PC3 program. Our behavioral health subsidiary, MHN, maintains a provider network comprised of approximately 58,811 psychiatrists, psychologists and other clinical categories of providers nationwide. Substantially all of these providers are contracted with MHN on an individual or small practice group basis and are paid on a discounted fee-for-service basis. Members who wish to access certain behavioral health services contact MHN and are referred to contracted providers for evaluation or treatment services. If a member needs inpatient services, MHN maintains a network of approximately 1,384 facilities. In addition to the physicians that are in our networks, we have also entered into agreements with various third parties that have networks of physicians contracted to them ( Third Party Networks ). In general, under a Third Party Network arrangement, Health Net is licensed by the third party to access its network providers and pay the claims of these physicians pursuant to the pricing terms of their contracts with the Third Party Network. 12

15 Hospital Relationships Our health plan subsidiaries arrange for hospital care primarily through contracts with selected hospitals in their service areas. These hospital contracts generally have multi-year terms or annual terms with automatic renewals and provide for payments on a variety of bases, including capitation, per diem rates, case rates and discounted fee-forservice schedules. Covered hospital-based care for our members is comprehensive. It includes the services of hospital-based physicians, nurses and other hospital personnel, room and board, intensive care, laboratory and x-ray services, diagnostic imaging and generally all other services normally provided by acute-care hospitals. Our nurses and medical directors are involved in a wide variety of medical management activities on behalf of our HMO and, to a somewhat lesser extent, PPO members. These activities can include discharge planning and case management, which often involves the coordination of community support services, including visiting nurses, physical therapy, durable medical equipment and home intravenous therapy. Ancillary and Other Provider Relationships Our health plan subsidiaries arrange for ancillary and other provider services, such as ambulance, laboratory, radiology, home health, chiropractic, acupuncture and other various therapy providers primarily through contracts with selected providers in their service areas. These contracts generally have multi-year terms or annual terms with automatic renewals and provide for payments on a variety of bases, including capitation, per diem rates, case rates and discounted fee-for-service schedules. In certain cases, these provider services are included in contracts our health plan subsidiaries have with PPGs and hospitals. See Item 1A. Risk Factors If we fail to develop and maintain satisfactory relationships on competitive terms with the hospitals, provider groups and other providers that provide services to our members, our profitability could be adversely affected for additional information on the risks associated with our provider relationships. Additional Information Concerning Our Business Competition We operate in a highly competitive environment in an industry currently subject to ongoing significant changes resulting from the ACA, business consolidations, new strategic alliances, market pressures, and regulatory and legislative reform including but not limited to the federal health care reform legislation described below in Government Regulation. Our primary competitors include managed health care companies, insurance companies, HMOs, third party administrators, self-funded groups and provider owned plans. Our health plans face substantial competition from both for-profit and nonprofit health plans that offer HMO, PPO, self-funded and traditional indemnity insurance products (including self-insured employers and union trust funds). We also face substantial competition from both for-profit and nonprofit health plans, as well as other non-health plan companies with respect to our contracts with state and federal government agencies, including our T-3, MFLC and PC3 contracts with the federal government, as well as our Medicaid and dual eligibles contracts, each of which may be subject to periodic re-competition. Some of our competitors have substantially larger enrollment and greater financial resources than we do. We believe that the principal competitive features affecting our ability to retain and increase membership include the range and prices of benefit plans offered, size and quality of provider network, quality of service, responsiveness to customer demands, financial stability, comprehensiveness of coverage, diversity of product offerings, market presence and reputation. The relative importance of each of these factors and the identity of our key competitors varies by market and product. We believe that we compete effectively against other health care industry participants. Our primary commercial and Medicare competitors in California are Kaiser Permanente, Anthem Blue Cross of California, Blue Shield of California, and United/PacifiCare. Together, these four plans and Health Net account for approximately 82% of the insured commercial and Medicare market in California. Based on the number of 2014 enrollees, Kaiser is the largest managed health care company in California and Anthem Blue Cross of California is the largest PPO provider in California. In addition, two of the major national managed care companies, Aetna, Inc. and CIGNA Corp., are active in California, with a significant share of the self-insured market. In Arizona, our primary commercial and Medicare competitors are BlueCross BlueShield of Arizona, Aetna, Inc., Cigna Corp., UnitedHealth Group, Inc., Anthem, Inc. and Humana, Inc. In the California and Arizona Medicaid markets, we compete for members with other entities that have been awarded Medicaid contracts in the same counties, and if an applicable Medicaid county or region is put up for bid, we 13

16 generally compete for state Medicaid contracts with other managed health care companies, both for profit and not-forprofit. Our Oregon health plan competes primarily with Regence Blue Cross Blue Shield of Oregon, Kaiser Permanente, Moda Health Plan, Inc., Providence Health Plan, and PacificSource Health Plans. With respect to the T-3 contract for the TRICARE North Region, and our MFLC and PC3 contracts, our primary competitors in the bidding process include Humana, United HealthGroup, Inc., Aetna, Inc., Anthem, Inc., Magellan Health Services, ValueOptions, Inc. and TriWest Healthcare Alliance, among others. If we fail to compete effectively to maintain or increase our market share, our results of operations, financial condition and cash flows could be materially adversely affected. For additional information on competitive conditions in our business, see Item 1A. Risk Factors The markets in which we do business are highly competitive. If we do not design and price our product offerings competitively, our membership and profitability could decline. Cognizant Transaction On November 2, 2014, we entered into a Master Services Agreement (as subsequently amended and restated, the "Master Services Agreement") with Cognizant Healthcare Services, LLC, a wholly owned subsidiary of Cognizant Technology Solutions Corporation (collectively, "Cognizant"). Under the terms of the Master Services Agreement, Cognizant will, among other things, provide us with certain consulting, technology and administrative services in the following areas: claims management, membership and benefits configuration, customer contact center services, information technology, quality assurance, appeals and grievance services, and non-clinical medical management support (collectively, the "BP and IT Services"). We will retain responsibility for our security policies and regulatory oversight. Concurrent with executing the Master Services Agreement, we entered into an asset purchase agreement with Cognizant (the "Asset Purchase Agreement"), through which Cognizant will purchase certain software assets and related intellectual property from us for $50 million. These assets will include one of our claims processing systems, which will be used to perform a portion of the BP and IT Services. See Note 3 to our consolidated financial statements under the heading Assets Held for Sale for additional information on the assets sold in this transaction. The transaction, including the related asset purchase (the "Cognizant Transaction"), is expected to close in the first half of 2015, subject to the receipt of required regulatory approvals. We expect that certain of our employees will become employees of Cognizant or its subcontractors, and that certain positions will be eliminated, as part of the Cognizant Transaction. The initial term of the Master Services Agreement is seven years, commencing on the later of (i) ten business days following final regulatory approval of the Cognizant Transaction, and (ii) March 1, 2015 (the "Commencement Date"). We have two options to extend the Master Services Agreement for one year each by giving notice to Cognizant no less than three months prior to the end of the then existing term. We will pay Cognizant for the BP and IT Services through a combination of fixed and variable fees, with the variable fees fluctuating based on our actual need for such services. Based on the currently projected usage of BP and IT Services over the initial term of the Master Services Agreement, we expect to pay Cognizant approximately $2.8 billion, subject to price adjustments described in the Master Services Agreement. The Master Services Agreement is expected to generate approximately $150 million to $200 million in annual general and administrative and depreciation expense savings for us by Some of the BP and IT Services will be provided on our premises, while other BP and IT Services will be performed at Cognizant facilities. Cognizant will provide us with transition services required to migrate those activities that will be performed at Cognizant facilities. The anticipated cost of such transition services is included in the expected cost of the BP and IT Services over the initial term described above. To protect our expectations regarding Cognizant s performance, the Master Services Agreement has minimum service levels that Cognizant must meet or exceed. Failure to meet these minimum service levels will result in service level credits to us as described in the Master Services Agreement. We retain the right to terminate the Master Services Agreement, in whole or in part, for, among other things, cause, convenience (including prior to the Commencement Date), certain performance failures, failure to obtain regulatory approvals, changes in law, force majeure, a change in the control of either Cognizant or us, a termination of the associated Business Associate Agreement, an adverse change in Cognizant s financial condition, if Cognizant becomes a competitor of ours or if damages paid by Cognizant to us pursuant to the Master Services Agreement exceed a certain level. If we terminate the Master Services Agreement prior to the Commencement Date, we shall pay 14

17 Cognizant a break-up fee of $10 million. If we terminate the Master Service Agreement following the Commencement Date for reasons other than cause, a termination of the associated Business Associate Agreement, a change in the control of Cognizant or Cognizant becoming a competitor of ours, we shall pay Cognizant termination fees calculated on a sliding scale that reduces over time and based on the applicable termination event, and such fees could be material. For example, the maximum termination fee payable by us pursuant to the Master Services Agreement is $300 million, which would be triggered in the event we terminated for convenience during the first year of the term of the Master Services Agreement. In addition, in the event we experience a change in control during the first year of the term of the Master Services Agreement, the maximum termination fee payable is $130 million, assuming that we (or our successor) elect to terminate the Master Services Agreement. We also retain the right to obtain disengagement assistance from Cognizant to facilitate the transition of BP and IT Services from Cognizant, regardless of whether the Master Services Agreement expires or is terminated. We will pay for the disengagement assistance through a combination of pre-determined charges and hourly fees for services for which there is no pre-determined charge. In addition, in the event of termination or expiration of the Master Services Agreement, we also retain the right to license at fair market value the software platform utilized by Cognizant in the performance of the BP and IT Services. Cognizant has in the past provided, and may provide in the future, services to us under separate agreements. Some of these historical services are included in the BP and IT Services that will be provided by Cognizant under the Master Services Agreement. The Cognizant Transaction is subject to certain risks and uncertainties, including with respect to the receipt of required regulatory approvals, which are discussed in further detail in "Item 1A. Risk Factors."Marketing and Sales We market our products and services to individuals and employer groups through internal sales staff, independent brokers, agents and consultants and through the Internet and the new ACA-mandated exchanges. For our group health business, we market our products and services utilizing a three-step process. We first market to potential employer groups, group insurance brokers and consultants. We then provide information directly to employees once the employer has selected our health coverage. Finally, we engage members and employers in marketing for member and group retention. For our large group business, in general, we solicit enrollees from the employee base directly during open enrollment periods when employees are permitted to change health care programs. We use a variety of techniques to attract new enrollees and retain existing members, which at times include, without limitation, direct mail, work day and health fair presentations and telemarketing. Similar methods are used by our Medicare business to market to eligible individuals. Our sales efforts are supported by our marketing division, which engages in product research and development, multicultural marketing, advertising and communications, and member education and retention programs. Several states in which we operate, including California and Arizona, have launched health insurance exchanges in response to the ACA. The establishment of the exchanges under the ACA created a new competitive insurance marketplace for individuals and small businesses. As these exchanges mature, we intend to refine and enhance our exchange related marketing strategies. Premiums for each employer group are generally contracted on a yearly basis and are payable monthly. We consider numerous factors in setting our monthly premiums, including changes in benefit design to address employer group needs and anticipated health care utilization rates as forecast by us based on the demographic composition of, and our prior experience in, our service areas. Premiums are also affected by applicable state and federal law and regulations that may directly or indirectly affect premium setting including, for example, premium loads for ACArelated taxes and fees assessed to health plans. Also, for policy years beginning January 1, 2014 and beyond, the ACA does not allow rating based on claims experience for small group and individual business. See Item 1A. Risk Factors We face competitive and regulatory pressure to contain premium prices. If the premiums we charge are insufficient to cover our health care costs, it could have a material adverse effect on our business, financial condition or results of operations for additional information on regulations and legislation impacting our premium setting. Mandated benefits (requiring the coverage of certain benefits as a matter of law, whether desired by the group or not) also impact premiums. For example, in California and elsewhere, the ACA has impacted the scope of essential health benefits that health plans are required to offer, and mental health parity laws have generally broadened mental health benefits under health insurance policies offered by us and other carriers. The ACA eliminated medical underwriting for medical insurance coverage decisions, including with respect to preexisting conditions (known as guaranteed issue ). For additional detail on these and other requirements of the ACA, as well as certain associated risks, see Government Regulation Health Care Reform Legislation and Implementation and Item 1A. Risk Factors Federal health care reform legislation has had and will continue to have an adverse impact on the costs of operating our business and a failure to successfully execute our operational and 15

18 strategic initiatives with respect thereto could adversely affect our business, cash flows, financial condition and results of operations. Information Technology Our business depends significantly on effective and efficient information systems. The information gathered and processed by our information management systems assists us in, among other things, pricing our services, monitoring utilization and other cost factors, processing provider claims, billing our customers on a timely basis, identifying accounts for collection and detecting fraud, security threats and other risks. Our customers and providers also depend upon our information systems for membership verification, claims status and other information. We have many different information systems that support our various lines of business and we develop new systems as needed to keep pace with continuing changes in technology and to support our operational needs, including potential business expansions. These systems require the ongoing commitment of significant resources for continual maintenance, upgrading and enhancement to meet our operational needs, evolving industry and regulatory standards, compliance with legal requirements (such as the ACA and ICD-10 (as defined below) and changing customer preferences). We have partnered with third parties to support our information technology systems and to help design, build, test, implement and maintain our information management systems, and in November 2014 we announced the Cognizant Transaction, which would significantly increase the scope of services provided to us by third parties, subject to regulatory approval of the transaction. For additional information on the Cognizant transaction, see " Cognizant Transaction" and Item 7. Management s Discussion and Analysis of Financial Condition and Results of Operations. Our merger, acquisition and divestiture activity also requires transitions to or from, and the integration of, various information management systems within our overall enterprise architecture. CMS recently adopted a new coding set for diagnoses, commonly referred to as ICD-10, which significantly expanded the number of codes utilized in claims processing. TheICD-10 coding set is currently required to be implemented by October We incurred significant expenses in 2014 to implement and support the ICD-10 coding set, and expect to incur incremental costs ahead of the required implementation date. In addition, our implementation and support of the requirements of the ACA and the CCI, including the dual eligibles demonstration, have required, and will continue to require the expenditure of significant resources as we continue to adapt to the changing guidance. For additional information on our information technology and associated risks, see Item 1A. Risk Factors We are subject to a number of risks in connection with our decision to enter into a master services agreement with Cognizant for the performance of a significant portion of our business process and information technology activities, Item 1A. Risk Factors If we fail to effectively maintain our information management systems, it could adversely affect our business, Item 1A. Risk Factors We are subject to risks associated with outsourcing services and functions to third parties and Item 1A. Risk Factors If we or our business associates that handle certain information on our behalf fail to comply with requirements relating to patient privacy and information security, among other things, our reputation and business operations could be materially adversely affected. Medical Management We believe that managing health care costs is an essential function for a managed care company. Among the medical management techniques we utilize to contain the growth of health care costs are pre-authorization or certification for certain outpatient services and inpatient hospitalizations and a concurrent review of active inpatient hospital stays and discharge planning. We believe that this authorization process, along with the inherent features of a capitation payment model, helps to reduce inappropriate use of medical resources and achieve efficiencies in referring cases to the most appropriate providers. We provide multiple models of care management and case management to our members, and also contract with third parties to manage certain conditions such as neonatal intensive care unit admissions and stays, as well as chronic conditions such as asthma, diabetes, chronic obstructive pulmonary disease, coronary artery disease and congestive heart failure. These techniques are widely used in the managed care industry and are accepted practices in the medical profession. Accreditation We pursue accreditation for certain of our health plans from the National Committee for Quality Assurance ( NCQA ) and URAC. NCQA and URAC are independent, non-profit organizations that review and accredit HMOs and other health care organizations. HMOs that apply for accreditation of particular product lines receive accreditation if they comply with review requirements and quality standards. The Medicare line of business of our California HMO has received NCQA accreditation with a score of commendable. HN California's commercial HMO/POS, HNL's PPO and our Arizona HMO's commercial lines of business and HN California s Medi-Cal line of business received NCQA 16

19 accreditation with a score of accredited. Our MHN subsidiary has received a URAC accreditation status of full for both Health Utilization Management and Health Network, which is the highest status awarded by URAC. Government Regulation Our business is subject to comprehensive federal regulation and state regulation in the jurisdictions in which we do business. These laws and regulations govern how we conduct our businesses and result in additional requirements, restrictions and costs to us. Certain of these laws and regulations are discussed below. New laws and regulations, or changes in the interpretation of existing laws and regulations, including as a result of changes in the political climate, could have an adverse effect on us. In the event we fail to comply with, or fail to respond quickly and appropriately to changes in, applicable law and regulations, our business, results of operations, financial condition and cash flows could be materially and adversely affected. For additional information, see Item 1A. Risk Factors Our businesses are subject to laws and significant rules and regulations, which increases our cost of doing business and could impact our financial performance by restricting our ability to conduct business or adversely affecting our ability to grow our businesses and Item 1A. Risk Factors Federal and state audits, reviews and investigations of us and our subsidiaries could have a material adverse effect on our operations, financial condition and cash flows. Health Care Reform Legislation and Implementation The ACA transformed the U.S. health care system through a series of complex initiatives. While we have experienced significant growth in our revenues and membership in certain products as a result of the ACA, the measures initiated by the ACA and the associated preparation and implementation of these measures have had, and will continue to have an adverse impact on our revenues and the costs of operating our business and could materially adversely affect our business, cash flows, financial condition and results of operations. Due in part to the scope and complexity of these initiatives, as well as their ongoing implementation, the ultimate impact of the ACA on us remains difficult to predict. The ACA imposes significant fees, assessments and taxes on us and other health insurers, health plans and industry participants. Among others, the ACA imposes a significant non-deductible tax (technically called a fee ) on health insurers, effective for calendar years beginning after December 31, In 2014, this health insurer fee was assessed at a total of $8 billion nationwide. In 2015, it is expected to be assessed at a total of $11.3 billion nationwide in 2015 and will increase annually thereafter. The health insurer fee will be allocated pro rata amongst industry participants based on a ratio of net health insurance premiums written for the previous calendar year to total net premiums written for the U.S. health insurance industry, subject to certain exceptions and adjustments. In September 2014, we paid the federal government a lump sum of $141.4 million for our portion of the health insurer fee. The ACA also required the establishment of state-run or federally facilitated exchanges where individuals and small groups may purchase health coverage. We are participating as QHPs in the currently operating exchanges in California and Arizona. For further information on these exchanges, see the discussion above under the heading Segment Information Western Region Operations Segment Western Region Exchanges. The ACA also contains premium stabilization provisions designed to apportion risk amongst insurers. These stabilization provisions include a permanent risk adjustment provision applicable to the individual and small group markets that became effective at the beginning of 2014, which will effectively transfer funds from health plans with relatively lower risk enrollees to plans with relatively higher risk enrollees to help protect against the consequences of adverse selection. Other premium stabilization provisions include the temporary reinsurance and risk corridors programs, which seek to ease the transition into the post- ACA market by helping to stabilize rates and protect against rate uncertainty in the initial years of the ACA. To adapt to this economic framework, we have dedicated significant resources and incurred significant general and administrative costs to implement numerous strategic and operational initiatives both within and outside the exchanges that, among other things, have required us to focus on and manage different populations of potential members than we have in the past. The final determination and settlement of amounts due or payable from these premium stabilization provisions will not occur until 2015, and there is no assurance that the strategy we have executed will be successful or that the investments we have made to incorporate these provisions will be profitable. The ACA allowed extended funds to those states that opted to expand Medicaid eligibility from a pool that included residents with incomes up to 100% of the federal poverty level ( FPL ) to an expanded pool of 17

20 residents with incomes up to 133% of the FPL. Medicaid expansion has driven a significant increase in our Medicaid enrollment in For additional discussion of Medicaid expansion and our Medicaid program, see the discussion above under the heading Segment Information Western Region Operations Segment Medicaid and Related Products. For further information on certain of the provisions above and how they have impacted our operations in 2014, see Note 2 to our consolidated financial statements under the heading Accounting for Certain Provisions of the ACA and Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Western Region Operations Reportable Segment. Other provisions of the ACA include, among other things: imposing an excise tax on high premium insurance policies; requiring premium rate reviews in certain lines of business; stipulating a minimum medical loss ratio (as adopted by the Secretary of HHS); limiting Medicare Advantage payment rates; increasing mandated essential health benefits in some lines of business; specifying certain actuarial value and cost-sharing requirements; eliminating medical underwriting for medical insurance coverage decisions, including guaranteed availability with respect to individual and group coverage; limiting the ability of health plans to vary premiums based on assessments of underlying risk in the individual and small group markets; increasing restrictions on rescinding coverage; prohibiting some annual and all lifetime limits on amounts paid on behalf of or to our members; limiting the tax-deductible amount of compensation paid to health insurance executives; requiring that most individuals obtain health care coverage or pay a penalty, commonly referred to as the individual mandate ; imposing a sales tax on medical device manufacturers; and increasing fees on pharmaceutical manufacturers. The schedule for implementation of the provisions of the ACA generally varies from as early as enactment to as late as A number of potentially significant provisions of the ACA became effective January 1, 2014, including the health insurer fee, the operation of QHPs purchased through the exchanges, the premium stabilization provisions described above, the guaranteed availability requirement, Medicaid expansion and the individual mandate. Other provisions, such as the excise tax on certain high-premium insurance policies, and the employer mandate for certain small- and mid-size employers, will not take effect until a later date. However, some of these provisions have had an earlier impact on our operations, including in connection with the setting of our premium rates and general and administrative expenses incurred in preparation for the ACA as discussed above. Certain legal and legislative challenges to the ACA remain including, but not limited to litigation in Arizona related to Medicaid expansion and a challenge to the validity of premium tax credits on federally-facilitated exchanges that is currently scheduled to be heard in the U.S. Supreme Court. We and other health insurance companies face uncertainty and execution risk due to the multiple, complex ACA implementations that are required in abbreviated time frames in new markets. Additionally, in many cases, our operational and strategic initiatives must be implemented in evolving regulatory environments and without the benefit of established market data. In addition, the lack of operating experience in these new marketplaces for insurers and, in certain cases, providers and consumers, increases the likelihood of a dynamic marketplace that may require us to adjust our operating and strategic initiatives over time, and there is no assurance that insurers, including us, will be able to do so successfully. Our execution risk encapsulates, among other things, our simultaneous participation in the exchanges, Medicaid expansion and the CCI, as described under the heading Segment Information Western Region Operations California Coordinated Care Initiative above. These initiatives require us to effectively incorporate new and expanded populations and, among other things, required us to effectively and efficiently restructure our provider network to, among other things, meet the ACA s dynamic environment. Any delay or failure by us to execute our operational and strategic initiatives with respect to health care reform or otherwise appropriately react to the legislation, implementing regulations, actions of our competitors and the changing marketplace could result in operational 18